Compass - April 2020
We look at smaller companies and advisers give their recommendations for various stages of life
By Annabel Brodie-Smith
Well, what a strange month it has been! I am writing from my ‘new’ office – our kitchen. I have a ‘new’ colleague – my nine-year-old son Fabian, who is sharing my desk, the kitchen table, while attending a virtual geography lesson on his new laptop.
First of all, and most importantly, I hope you are all well and healthy. Coronavirus has been devastating for many people. We are so fortunate to have people working very hard in the NHS and elsewhere to keep us healthy and safe. It has also radically changed the way we live, work, shop and socialise. There are plenty of new worries, some are serious (my 83-year-old Mother is struggling in Wales) and some are trivial (why are people panic buying loo roll?)
And not surprisingly with vast swathes of the world in lockdown, March has been a rocky ride for global markets. The FTSE 100 has had its worst three-month performance since the Black Monday crash in 1987, down 25%. It’s a similar scenario for the Dow Jones and the worst quarter for global markets since the financial crisis.
At times like this it’s reassuring to hear from some of our most experienced managers like the legendary Peter Spiller, who has broken records by remaining at the helm of Capital Gearing Trust for 38 years. Peter has a wonderfully deep and commanding voice and I can almost hear him say: “In fifty years of investing I have experienced a number of bear markets. They do come to an end, so avoid despair and stay calm. Precise timing is more problematic, and usually impossible.” We hear from him and Austin Forey (25 years at JPMorgan Emerging Markets), Katie Potts (26 years at Herald) and Hugh Young (24 years at Aberdeen Standard Asia Focus).
Talking of experience, our investment writer Ian Cowie has some heartfelt words of wisdom on the markets. He concludes: “Looking back over more than a quarter of a century as an individual investor, I would say the best time to buy shares is often when we least feel like it.” Of course, none of us know what markets will do next or what the extent of the impact of coronavirus will be, but after 23 years of investing myself I think Ian’s got a point. He also talks to Ben Rogoff of Polar Capital Technology on how technology may benefit from the long-term behaviour changes brought about by COVID-19. Ian talks to the manager of Worldwide Healthcare Trust on the outlook for the healthcare sector too.
Healthcare is clearly front of mind and we recently talked to managers about the prospects for a vaccine and how their portfolio companies are contributing to the fight against the pandemic. It’s both comforting and fascinating to hear about their investments. Calculus VCT invests in Mologic, which is developing a rapid test for coronavirus, which could mean test results are provided in 20 minutes. International Biotechnology invests in Gilead, which has the most advanced potential treatment with an anti-viral drug called remdesivir, previously in development for Ebola. The managers remain positive about prospects for the healthcare sector, with Paul Major of BB Healthcare Trust explaining: “When the dust settles and COVID-19 has thankfully become a historical consideration, the ‘new normal’ will still feature the same demographic and societal drivers of a growing and ageing population.”
Finally, we are taking a look at the topical issue of dividends. This week it was announced that the banks are cancelling their dividends for 2019. Many other listed businesses have also announced they are cutting or suspending dividends. The dividend hero investment companies are the 21 investment companies which have increased their dividends every year for 20 years or more. They can do this because investment companies can squirrel away up to 15% of the income they receive each year from their portfolio when markets are good. They can then use this rainy-day fund (called the revenue reserve) to boost dividends in challenging markets like these. Of course, dividends are not guaranteed and this week the analysts at Winterflood have been looking at whether these dividend rises are sustainable. They conclude: “For the time being, we believe that these investment trusts are attractive for investors looking for a degree of dividend certainty”.
Similarly this week, Investec analysed the sustainability of dividends for investment companies in the UK Equity Income sector. They concluded these companies can withstand a 30% fall in portfolio income and still increase their dividends by 3% through using their reserves. Interestingly, if there was a further 30% fall in portfolio income for a second year, theoretically eight companies would still be able to pay a 3% rise, although their boards would have some difficult decisions to make as to whether this was in shareholders’ best interests or not.
I do hope despite all the depressing news you manage to have a healthy and as positive a month as possible. In the pursuit of staying sane, I have been doing the ‘Insanity’ exercise video, which is living up to its name, going for long walks and gardening.
On Friday my husband has a big birthday and instead of celebrating in Venice, we will be at home. But we are all beyond excited about the arrival of his surprise present, a barbeque.
Let’s hope the weather’s sizzling!
Wishing you a Happy Easter.
Annabel Brodie-Smith, Communications Director AIC
Bearing with it
The industry's longest-serving managers share lessons they've learned
Following the deep market falls of recent weeks, the AIC has collated insights from some of the investment company industry’s longest-serving managers.
Out of all AIC member investment companies (ex VCTs) with a history of longer than ten years, 90 (46%) have had at least one of their current fund managers in place for ten years or more. Some managers have much longer track records. Eighteen investment companies have had the same manager for more than 20 years.
Annabel Brodie-Smith, Communications Director of the AIC, said: “Coronavirus has had a devastating impact on many people’s lives. It has also swiftly changed the way we live, work, shop and socialise. It’s brought an end to the longest bull market in history and caused sharp market falls. Amidst all this market uncertainty, it’s reassuring to know that nearly half of AIC member investment companies have had the same manager for ten years. Eighteen investment company managers have steered their companies through at least 20 years of market ups and downs, experience that will serve them well in the current volatile market conditions.”
The longest-serving investment company manager is Peter Spiller, who has run Capital Gearing for 38 years. Second is Simon Knott, the manager of Rights & Issues for 36 years. Next is James Henderson who has managed Lowland for 30 years. Completing the top five are Alistair Whyte and Job Curtis who have headed Aberforth Smaller Companies and City of London for 29 and 28 years respectively.
Some of the longest-serving managers share their bear market insights and the most important lessons they have learned below. A full table of the longest-serving managers is also included.
Bear market insights
Peter Spiller, Manager of Capital Gearing, said: “In fifty years of investing I have experienced a number of bear markets. They do come to an end, so avoid despair and stay calm. Precise timing is more problematic, and usually impossible. Currently the battle in equity markets is between exceptional fiscal and monetary stimulus providing support against an economic slump, with luck short-term, and a credit crunch exacerbated by the spat between Saudi Arabia and Russia over oil. Excessive corporate debt has turned a drama into a crisis.”
Katie Potts, Manager of Herald, said: “I have been managing Herald Investment Trust from inception in 1994. The current headache always seems to be the worst. People looked over the edge fearing the collapse of the banks in 2008, but it did not happen – they were rescued, and in hindsight little damage was done to most people’s lives. The lesson is don’t panic.”
Austin Forey, Portfolio Manager of JPMorgan Emerging Markets Investment Trust, said: “Very volatile markets are always stressful, but we have some experience to draw on in terms of what not to do. In a big downturn one thing to avoid is the temptation to run for cover after the crash has happened: it’s very easy to act pro-cyclically, but you should try to avoid that.”
Hugh Young, Manager of Aberdeen Standard Asia Focus, said: “During any crisis one of the most important things to do is to keep calm. Markets sell off and share prices plummet but it’s important not to panic and above all you need to pause for thought. The breakout of COVID-19 in China, its spread across the region and now globally have already impacted economic activity and company profitability and will continue to do so.”
Most important lesson learned
Austin Forey, Portfolio Manager of JPMorgan Emerging Markets Investment Trust, said: “Firstly, don’t force ideas or feel that you have to be finding something to buy and sell every day: concentrate on what makes a difference. Secondly, work out what you’re trying to do and don’t let market cycles or performance cycles drag you off course.”
Buying the dips
Hugh Young, Manager of Aberdeen Standard Asia Focus, said: “The slide in markets has certainly meant companies are a lot cheaper than they once were. But during my over 30-year career I’ve learnt not to focus solely on price. Valuations attached to some companies may be justifiable, if possibly still too expensive, given the headwinds they face. For other companies it could be a good entry point for patient investors. For Asia Focus’ portfolio we’ve identified opportunities around the region where share prices are attractive and the management, balance sheet strength and business model are also compelling. Importantly they’re in good shape to weather the challenges ahead and capitalise on opportunities to take market share.”
Katie Potts, Manager of Herald, said: “I have been running high cash positions because I have been concerned by the high levels of debt of consumers, government and corporates alike. In the corporate sector the leverage in private equity owned companies has been eyebrow-raising. I hope that a silver lining will be the reminder that it is better to have companies funded by equity than debt. Generally, leverage in quoted companies is non-existent or modest, and shareholders are well able to invest further capital in solid businesses that have short-term requirements. The quoted market should be a relatively safe haven, albeit some sectors such as travel and leisure will be challenged.”
Peter Spiller, Manager of Capital Gearing, said: “We entered this period with a defensive position and have added to equity holdings where companies look able to endure unprecedented poor short-term conditions and are trading at large discounts to their long-term value. If the analogy to war means anything, it is that wars always produce inflation; do not be misled by the weakness in the CPI that we expect in the next few months. Inflation-protected assets still have an important role in any long-term portfolio.”
Katie Potts, Manager of Herald, said: “The technology sector is relatively well placed. The surge in home working is leaving unused processing power and storage on the desk. It is also creating a surge in demand for resources to work at home – internet shopping, laptops, internet bandwidth, video conferencing, datacentre cloud processing power and storage for example. In addition, while jobs are cut IT systems remain indispensable for most businesses, and the costs and expenditure will continue.
“The scale of money being printed necessitates low interest rates for a long time, and as the virus recedes an inflationary boom with rising asset prices seems highly probable next year.”
Hugh Young, Manager of Aberdeen Standard Asia Focus, said: “The outlook for the region over the next few months is uncertain given the numerous factors at play. Encouragingly policymakers' reaction has been swift and they continue to have policy tools – both monetary and fiscal – at their disposal. Longer term the economic balance of power will continue to shift from west to east, and Asia will remain a key driver of global growth and home to some of the fastest growing companies in the world.”
Austin Forey, Portfolio Manager of JPMorgan Emerging Markets Investment Trust, said: “As more money is allocated passively and investor time horizons get ever shorter, patient long-term investors should find more and more opportunity.”
For a full list of the longest-serving managers please click here.
Longest-serving managers over 20 years. Source: AIC/Morningstar (as at 27 March 2020)
A bumpy ride
Ian Cowie shares his experiences of investing through market highs and lows
Shareholders suffered a shocking first quarter of 2020, with some stock market indices losing a third of their value before enjoying the biggest bounce in a decade or more. No wonder many people feel fearful about the future.
Fortunately, in this individual investor’s personal experience, there are reasons to be cheerful; to keep calm and carry on. One of the first lessons I learned as a cub reporter in the City more than 30 years ago is that there should be no need to turn paper losses into real ones.
Provided you stick to the golden rule of only investing money you can afford to commit for five years or more, you should be able to avoid selling shares when prices are temporarily depressed. For example, many people remember that Black Monday, 19 October 1987, saw the FTSE 100 index of Britain’s biggest shares fall by 10% with a similar drop the next day. Fewer folk recall that the index actually ended that calendar year slightly higher than it began.
Of course, the past is not necessarily a guide to the future. However, according to the Barclays Equity Gilt Study 2019, it remains a historical fact that if you had invested for any period of five consecutive years since 1899 there was a three-in-four probability of shares delivering a higher return than deposits. To be precise, shares reflecting the changing composition of the London stock market did better than deposits in 76% of five-year periods and beat bonds in 72% of them.
More recently and more specifically, I remember how share prices plunged when the technology, media and telecommunications (TMT) bubble exploded at the start of this century. Despite that, being a shareholder in Polar Capital Technology Investment Trust (stock market ticker: PCT) since the early Noughties has proved very profitable and it remains one of my top 10 holdings by value.
According to independent statisticians Morningstar, PCT delivered total returns of 405% over the last decade; 157% over the last five years and, perhaps most remarkably, remains 14% up over the last very difficult year. Despite those facts, this trust trades at 1% discount to its net asset value (NAV).
Looking forward, PCT may benefit from changes in the way we live. Its manager, Ben Rogoff, told me: “5G infrastructure will be a big focus for stimulus spending in the second half of 2020, particularly if many of us are still working from home as a result of the coronavirus crisis. We expect to see long-lasting behavioral changes for both consumers and corporates alike, even after this current phase of containment passes, and that may be longer than we all hope. While our sector is not immune from the economic slowdown, with strong secular tailwinds, the right technology stocks may prove more defensive than many expect.”
Similarly, another long-term top 10 holding in my ‘forever fund’ is doing well by doing good; helping to fund research to fight the coronavirus. Worldwide Healthcare (WWH) delivered total returns of 354% over the last decade; 53% over the last five years and 3% over the last year. Its co-manager, Trevor Polischuk, said: “Many companies are accelerating their efforts in the anti-viral space in hopes of creating a treatment to help infected patients.
“Whilst the healthcare industry moves into the forefront of the war against COVID-19, our focus remains on the positive fundamentals of the industry – its near-term defensive qualities and long term growth prospects driven by innovation and societal secular demand.”
Many investment companies have survived even more serious shocks than those we are experiencing now, such as two World Wars and the Great Depression. Better still, dozens of investment companies have delivered rising dividends every year for more than a decade, paying shareholders to be patient.
It is an oddity of investment that most people are keen to buy shares when prices are high and shun them when prices are low; the opposite of how they behave in any other aspect of their lives. However, the first step toward making a profit is often to buy low.
There are plenty of obvious reasons to be worried at present and the future remains unknowable but there are lessons to be learned from the past. Looking back over more than a quarter of a century as an individual investor, I would say the best time to buy shares is often when we least feel like it.
Managers explore the prospects for a cure or test
With vast swathes of the world in lockdown, the one question on everyone’s minds is how long will it take to develop a vaccine against COVID-19? The AIC has spoken to investment company and VCT managers about the prospects for a vaccine and how their portfolio companies are contributing to the fight against coronavirus.
What are the prospects for a vaccine?
Paul Major, Manager of BB Healthcare Trust, said: “We are optimistic that a vaccine will be in commercial production within 18 months. There are more than 40 companies and groups working on a variety of approaches and we are mindful of the swine flu pandemic of 2009, when a vaccine was delivered within around six months from the WHO declaring it an emergency situation.”
James Douglas and Gareth Powell, Co-Managers of Polar Capital Global Healthcare Trust, said: “As of 20 March, there were two vaccine candidates already in clinical trials and another 42 vaccine candidates in pre-clinical development. There are some hopes that we may see initial clinical data before year-end but it is likely that it will take a good 12 to 18 months for larger clinical studies to read out for any of these vaccine candidates.
“Even with some positive data, manufacturing hundreds of millions of doses of a new vaccine for everyone will be a significant challenge – it is likely that initial vaccine doses will be given to healthcare workers. That said, there are a number of collaborative efforts emerging to solve the manufacturing issue with governments playing a key role. For this reason, the commercial implications are difficult to assess and, in most cases, projects are being advanced as quickly as possible without much thought about the profit to be gained.”
Are any of your portfolio companies working on treatments or tests?
John Glencross, CEO of Calculus Capital which manages the Calculus VCT, said: “Our portfolio company Mologic is developing a rapid test for coronavirus. They have been awarded £1 million of UK Aid to develop this test. On the back of this, the Prime Minister Boris Johnson visited Mologic’s lab in Bedfordshire, where scientists are using expertise and experience from previous epidemics to create a quicker and cheaper way to diagnose coronavirus. This rapid test could mean results are provided in 20 minutes, and without the need of a medical professional or sending samples to labs for testing. This will mean patients can be treated quickly, reducing the risk of them passing the virus on to others and helping them to recover faster.
“Another portfolio company, Genedrive, has pivoted part of its core resources towards development of two SARS-COV-2 tests, which can determine whether someone is infected with coronavirus. They anticipate that a clinically validated test could be available in approximately eight weeks. Based on discussions with sizeable third-party suppliers the company expects it could have the ability to ramp up quickly to high production volumes of over 10,000 tests per hour.
“Finally, a third portfolio company, Yourgene Health, has unveiled a contract manufacturing agreement with Novacyt SA for a COVID-19 diagnostic test. Under the deal, Yourgene will use its manufacturing facility in Manchester, UK, to ramp up production of Novacyt’s COVID-19 test, with the first batches to be shipped from the Manchester site in the next few weeks.”
Trevor M. Polischuk, Portfolio Manager of Worldwide Healthcare Trust, said: “Many companies are accelerating their efforts in the anti-viral space in hopes of creating a treatment to help already infected patients. In Japan, Takeda's recent acquisition of Shire and their plasma derived therapy business has led to an investigational new treatment to boost the immune function of infected COVID-19 patients. Chugai's anti-inflammatory drug, Actemra, may also be useful in treating infected patients who are suffering from severe lung dysfunction resulting from coronavirus.”
Ailsa Craig, Manager of International Biotechnology Trust, said: “The only way to prevent COVID-19 is through a vaccine or self-isolation. There is no other way of protecting people from infection. In terms of treatments, yes there are many programmes ongoing. Gilead has the most advanced potential treatment in terms of timescale. They expect their trials to read out in April for a drug called remdesivir. This is an anti-viral drug which was in development for another virus, Ebola. Gilead has initiated two phase 3 trials in China and several more in the US. We owned Gilead in the portfolio prior to the outbreak due to its compelling valuation and solid HIV business and we have added to the position in recent months.”
What is the impact of the sell-off?
James Douglas and Gareth Powell, Co-Managers of Polar Capital Global Healthcare Trust, said: “We have a high level of conviction that the recent market sell-off is creating some really interesting, medium-term opportunities in the healthcare sector. Unless you take the view that the demand for healthcare services is permanently impaired, we believe we will see a strong recovery.”
Paul Major, Manager of BB Healthcare Trust, said: “As with all market sell-offs, the second phase is disordered and largely indiscriminate and this has created some interesting opportunities, especially in mid-cap specialty pharma/biotech, services and managed care. We have been gradually increasing our gross exposure for about a week now and will continue to do so, albeit at a measured pace. We think the overall risk/reward is now to the upside, with many of the ‘unknowns’ around this epidemic and its impact now well appreciated, if not fully quantifiable. We see many companies where sentiment is already baking in a worst-case scenario.”
What is the outlook for the sector?
Stephanie Sirota, Director at RTW Venture Fund and Partner at RTW Investments LP, said: “High-beta sectors like biotech typically sell off hard during periods of stress and generalist investor sentiment can remain tepid for a while. That said, we are encouraged by the quality and the pace of scientific development and we are hopeful that positive catalysts will help drive the recovery. We are seeing compelling opportunities in this market given where valuations are and how well capitalised company balance sheets are. Getting past the current crisis, we think the future is bright, especially in genetic medicines, targeted oncology, and across rare diseases.”
Paul Major, Manager of BB Healthcare Trust, said: “Healthcare stands apart from the wider economic cycle and consumer sentiment. We consume these services because we need them, not because we want to. When the dust settles and COVID-19 has thankfully become a historical consideration, the ‘new normal’ will still feature the same demographic and societal drivers of a growing and ageing population. In the short term, there will be a tailwind as the backlog of postponed elective procedures is addressed.
“Moreover, the crisis has highlighted the stark inefficiencies and general under-investment in the healthcare system over many years, and political and consumer resistance to paying for more service resilience in future has melted away.”
Ailsa Craig, Manager of International Biotechnology Trust, said: “If you look at the performance of the Nasdaq Biotech Index over the past month, the sector has only fallen back to Autumn 2019 levels which is significantly better than many other sectors. This is remarkable considering that biotechnology is deemed to be a high-beta sector and such sectors tend to underperform in down markets.
“We think this shows that investors understand the sector’s defensive characteristics: regardless of an economic downturn, the global population will still grow, people are living longer and more of them are able to purchase medicines, people will still get sick and society will still need medicines. In the longer term, the virus outbreak will subside and investors will start being drawn back in by the attractive valuations. We are in a strong position with cash and potential gearing which we can put to work over the coming weeks and months.”
Holding out for a hero
We reveal our latest lineup of dividend heavyweights
The AIC has published the latest list of its 21 dividend heroes, the investment companies which have consistently increased their dividends for 20 or more years in a row. In these tough market conditions and with interest rates falling, the reliability of income streams is even more important.
Four dividend heroes have raised their dividends consistently for over half a century. City of London Investment Trust, Bankers Investment Trust and Alliance Trust lead the way with 53 years of consecutive rises. Caledonia Investments follows close behind with 52 years of increases.
A further seven heroes have increased their dividends for 40 or more years in a row and another five have done so for more than 30 consecutive years.
So far in 2020, eight dividend heroes have announced a further year of increases. In March, JPMorgan Claverhouse announced its 47th annual increase, F&C Investment Trust announced its 49th, Witan announced its 45th and Alliance Trust announced its 53rd. In February, Brunner Investment Trust (48th), Scottish American (40th) and Temple Bar (36th) announced increases and Bankers Investment Trust announced its 53rd annual increase in January.
Annabel Brodie-Smith, Communications Director of the AIC, said: “With the market turmoil of the past few weeks, it’s comforting to know that the 21 dividend heroes have been raising their dividends through thick and thin for decades. City of London, Bankers and Alliance have increased their dividends for an impressive 53 straight years. To put this in perspective, this means they have been increasing their dividends every year since the Beatles released Sgt. Pepper’s Lonely Hearts Club Band. Whilst there’s no guarantee, the fact investment companies can save up to 15% of their income each year has helped them to carry on raising dividends through such intense market downturns as the 1987 crash, the dot com bubble bursting and the financial crisis. With the difficulties facing markets at the moment, the power of investment companies to deliver rising dividends is reassuring for investors.”
Alex Crooke, Fund Manager of The Bankers Investment Trust, said: “Being a global investment trust and having revenue reserves are great advantages to maintain and continue the legacy of The Bankers Investment Trust’s 53 years of consecutive dividend growth. Our global reach means access to more areas of growth when certain sectors or countries stumble and the revenue reserve enables the trust to hold back some income in the strong years of corporate dividend growth to pay out in leaner ones. We recognise the importance of delivering a reliable and growing income to shareholders and over recent years have built the revenue reserves to cope with the fluctuations of currencies or the need to prioritise asset allocation decisions towards lower yielding markets.”
The key to the dividend heroes’ success is investment companies’ income advantage. Unlike open-ended funds, investment companies can hold back up to 15% of the income they receive from their portfolio each year and tuck it into a revenue reserve. This rainy-day pot means investment companies can save income in good years to boost dividends in leaner ones, enabling them to consistently raise dividends through thick and thin.
Source: AIC/Morningstar. Investment company dividend heroes at 2 April 2020
Full dividend information on each investment company is available on the AIC’s website: www.theaic.co.uk. The website shows each investment company’s revenue reserve. This is the income which has been retained by an investment company which can be used to support dividends in more difficult years. The website also shows each investment company’s dividend cover. This shows how many years the current revenue reserve could pay the investment company’s last full financial year of dividends.
The AIC’s website also has Income Finder, a suite of tools and resources to help income-seeking investors research investment companies. Investors can build a virtual portfolio of income-paying investment companies, track dividend dates and see how much income they could have received over a year.